Kocherlakota: Fed Tolerating Higher Inflation Risks

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota took issue with what he said are the central bank’s shifting objectives for inflation since last year, saying it weakens policy makers’ credibility.

Actions taken by the Federal Open Market Committee this year “suggest that it is more willing to tolerate inflation risks,” by letting price gains climb above 2 percent to push down unemployment, Kocherlakota said today in Minneapolis. “If this drift in inflation risk tolerance were to persist, or were expected to persist, it could give rise to a damaging increase in inflationary expectations.”

The regional chief is among the three Fed officials who dissented from the FOMC’s moves to ease policy at the two most recent meetings in Washington. He said the FOMC has made its mission for policy unclear, something that can be remedied by more “explicit communication.”

“I believe that the FOMC’s decision-making in 2011 has introduced a lack of clarity about its monetary policy mission,” Kocherlakota, 48, said in his remarks at the Harvard Club of Minnesota.

Minutes of the Fed’s most Sept. 20-21 meeting show that at least some committee members wanted to retain the option of a third round of asset purchases, and that many are open to the idea of tying the Fed’s low-rate pledge to more specific developments in the economy. Most participants favored providing the public with more information on the central bank’s goals and how those objectives influence the Fed’s decisions, according to the minutes released on Oct. 12.

Growth Pace

Data released since the FOMC’s last gathering show the U.S. economy grew at a 1.3 percent pace in the second quarter, faster than initially estimated, and American employers added 103,000 payroll jobs in September. Meanwhile, confidence among U.S. consumers unexpectedly dropped in October as Americans’ outlooks for the economy and their finances slumped to the lowest level since 1980, according to the Thomson Reuters/University of Michigan preliminary index of consumer sentiment.

Kocherlakota voted against the FOMC’s Sept. 21 decision to push down longer-term interest rates through the so-called Operation Twist. He also challenged the committee’s Aug. 9 pledge to keep the benchmark U.S. interest rate low through at least mid-2013, preferring instead to maintain a previous commitment to do so for “an extended period.”

November Decision

Since the Fed’s November decision to undertake a round of $600 billion in purchases of long-term Treasuries, unemployment has dropped from 9.8 percent to 9.1 percent in September. Meanwhile, the central bank’s preferred inflation measure has climbed from 1 percent to an anticipated 1.9 percent in October, he said.

Kocherlakota said he expects that inflation gauge, the personal consumption expenditures price index minus food and energy, to rise to just over 2 percent in the coming years while he sees unemployment falling to about 8 percent by the end of 2013.

These changes “suggest that the committee should have lowered the level of monetary accommodation over the course of the year,” the policy maker said. “Instead, the committee chose to raise the level of monetary accommodation.”

In response to audience questions after his speech, Kocherlakota said monetary policy can’t be operated “at a short-term frequency,” but rather over a “one-, two-, three- year horizon.” He also said it’s “very troubling” how long the U.S. recovery is taking and that the country is “going to have to confront” its long-term fiscal policy issues.

U.S. Fundamentals

“The fundamentals of the U.S. economy are very strong,” he said. “The future does look very bright” and yet “very challenging” over the next four or five years.

Kocherlakota added that European officials “have done a good job up until now in staying in front of events” in their region.

Stocks advanced, driving European shares up the most in two weeks, as commodities and the euro rose on optimism policy makers are moving closer to containing the debt crisis. The Standard & Poor’s 500 Index added 1.3 percent at 2:27 p.m. New York time, climbing to what would be the highest closing level since Aug. 3.